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EX-21.1 - CENTRAL VIRGINIA BANKSHARES INCex21.htm
EX-23.1 - CENTRAL VIRGINIA BANKSHARES INCex23.htm
EX-31.2 - CENTRAL VIRGINIA BANKSHARES INCex31-2.htm
EX-10.10 - CENTRAL VIRGINIA BANKSHARES INCex10-10.htm
EX-31.1 - CENTRAL VIRGINIA BANKSHARES INCex31-1.htm
EX-99.1 - CENTRAL VIRGINIA BANKSHARES INCex99-1.htm
EX-32.1 - CENTRAL VIRGINIA BANKSHARES INCex32-1.htm
EX-99.2 - CENTRAL VIRGINIA BANKSHARES INCex99-2.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010

Commission file number:  000-24002
 
CENTRAL VIRGINIA BANKSHARES, INC.         
(Name of registrant as specified in its charter)
 
Virginia
(State or other jurisdiction of
incorporation or organization)
54-1467806
(I.R.S. Employer
Identification No.) 
 
2036 New Dorset Road, Post Office Box 39
Powhatan, Virginia
(Address of principal executive offices)
23139-0039
(Zip Code)
 
Registrant’s telephone number, including area code: (804) 403-2000

Securities registered under Section 12(b) of the Exchange Act:
 
                                                                                                        
 
Title of Each Class
Name of Each Exchange
on Which Registered
Common Stock, par value $1.25 per share
The Nasdaq Stock Market

Securities registered under Section 12(g) of the Exchange Act:
None

 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.      Yes o No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
 

 
 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o
Accelerated filer o
   
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company x
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o
No x
 
 

 The aggregate market value of the Common Stock held by non-affiliates, computed by reference to the closing sale price of the Common Stock as reported on The Nasdaq Global Market on June 30, 2010, the last business day of the registrant’s most recently completed second fiscal quarter, was $3,787,796.
 
 
At March 25, 2011 there were 2,625,786 shares of the registrant’s Common Stock outstanding.
 
 
DOCUMENTS INCORPORATED BY REFERENCE
 
     Portions of the definitive proxy statement for the 2011 Annual Meeting of Shareholders are incorporated by reference into Part III of this report.
 





















 
 

 

 
 
     
     
     
     
     
     
     
     
 
   
 
     
     
 
 
     
 
 
     
     
 
 
     
     
     
     
     
     
 
 
     
 
 
     
     
     
 


 
BUSINESS
 
General
 
The Company and the Bank. Central Virginia Bankshares, Inc. (the “Company”) was incorporated as a Virginia corporation on March 7, 1986, solely to acquire all of the issued and outstanding shares of Central Virginia Bank (the “Bank”). The Bank was incorporated on June 1, 1972 under the laws of the Commonwealth of Virginia and, since opening for business on September 17, 1973, its main and administrative office had been located on U.S. Route 60 at Flat Rock, in Powhatan County, Virginia. In May 1996, the administrative offices were relocated to the Corporate Center in the Powhatan Commercial Center on New Dorset Road located off Route 60 less than one mile from the main office. In June 2005, the original main office was closed and relocated nine-tenths of a mile east, to the then just completed new main office building.
 
The Company maintains an internet website at www.centralvabank.com, which contains information relating to it and its business. The Company makes available free of charge through its website its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these documents as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the Securities and Exchange Commission. Copies of the Company’s Audit Committee Charter, Nominating Committee Charter, Compensation Committee Charter and Code of Conduct are included on the Company’s website and are therefore available to the public.
 
Principal Market Area. The Bank’s primary service areas are Powhatan and Cumberland Counties, eastern Goochland County and western Chesterfield and western Henrico Counties. The table below reflects the 2010 population of our market and growth rates from the 2000 census to the 2010 census from the U.S. Census Bureau.  Similar growth rates are expected for the foreseeable future.
 
   
2010 Census Data
   
% of Total Market
   
Population Growth Rate from 2000 to 2010
 
Powhatan County
    28,046       4.1 %     25.3 %
Cumberland County
    10,052       1.5 %     11.5 %
Goochland County
    21,717       3.2 %     29.1 %
Chesterfield County
    316,236       46.3 %     21.7 %
Henrico County
    306,935       44.9 %     17.0 %
  Total Market Served
    682,986       100.0 %        
 
The table below reflects the Bank’s various operating properties:
 
 
Property
Property Location
Operating Purpose
Main Office
Flat Rock, Powhatan County
Main Office and Branch
Village Marketplace
Village of Midlothian, Chesterfield County
Branch
Market Square Shopping Center
Brandermill, Chesterfield County
Branch
Bellgrade Shopping Center
Chesterfield County
Branch
Cumberland County Courthouse
Cumberland County
Branch
Cartersville
Cumberland County
Branch
Wellesley
Short Pump, Henrico County
Branch
 
The Bank’s present intention is to continue its activities in its current market area which it considers to be an attractive and desirable area in which to operate.
 


Banking Services. The principal business of the Bank is to attract deposits and to loan or invest those deposits on profitable terms. The Bank engages in a general community and commercial banking business, targeting the banking needs of individuals and small to medium sized businesses in its primary service area. The Bank offers all traditional loan and deposit banking services as well as newer services such as Internet banking, telephone banking, debit cards, and other ancillary services such as the sales of non-deposit investment products through a partnership with Infinex, Inc. a registered broker-dealer an member of FINRA and SIPC.  The Bank makes term loans, both alone and in conjunction with other banks or governmental agencies. The Bank also offers other related services, such as ATMs, travelers’ checks, safe deposit boxes, deposit transfer, notary public, escrow, drive-in facilities and other customary banking services. The Bank’s lending policies, deposit products and related services are intended to meet the needs of individuals and businesses in its market area.
 
The Bank’s plan of operation for future periods is to continue to operate as a community bank and to focus its lending and deposit activities in its primary service area. As the Bank’s primary service area continues to shift from rural to suburban in nature, the Bank will compete aggressively for customers through its traditional personal service and hours of operation. The Bank will also emphasize the origination of construction loans as the area becomes more developed. Consistent with its focus on providing community based financial services, the Bank does not plan to diversify its loan portfolio geographically by making significant loans outside of its primary service area. While the Bank and its borrowers are directly affected by the economic conditions and the prevailing real estate market in the area, the Bank is better able to monitor the financial condition of its borrowers by concentrating its lending activities in its primary service area. The Bank will continue to evaluate the feasibility of entering into other markets as opportunities to do so become available.

Recent Regulatory Developments.  Over the past thirty-six months, the Bank’s capital position has been negatively impacted by deteriorating economic conditions that in turn has caused losses in its investment and loan portfolios. As a result of a 2009 examination by the Virginia Bureau of Financial Institutions and the Federal Reserve Bank of Richmond, the Bank entered into a written agreement with the Bureau of Financial Institutions and the Federal Reserve on June 30, 2010.  The written agreement is available on the Federal Reserve’s website at http://www.federalreserve.gov/newsevents/press/enforcement/20100706a.htm.  The written agreement requires the Bank to significantly exceed the capital level required to be classified as “well capitalized.” It also provides that the Bank shall:
 
 
·
submit written plans to the Bureau of Financial Institutions and the Federal Reserve to strengthen corporate governance and board and management structure;
 
·
strengthen board oversight of the management and operations of Central Virginia Bank;
 
·
strengthen credit risk management and administration;
 
·
establish ongoing independent review and grading of our loan portfolio;
 
·
enhance internal audit processes;
 
·
improve asset quality;
 
·
review and revise our methodology for determining the allowance for loan and lease losses (“ALLL”) and maintain an adequate ALLL;
 
·
maintain sufficient capital;
 
·
establish a revised contingency funding plan;
 
·
establish a revised investment policy; and
 
·
improve our earnings and overall condition.  
 
The written agreement also restricts the payment of dividends and any payments on trust preferred securities or subordinated debt, and any reduction in capital or the purchase or redemption of stock without the prior approval of the Bureau of Financial Institutions and the Federal Reserve.  The Bank has complied with the initial requirements of the written agreement, including submitting plans to significantly exceed the capital level required to be classified as “well capitalized”, improve corporate governance, strengthen board oversight of management and operations, strengthen credit risk management and administration, and improve asset quality.  The Bank continues to address the requirements of the written agreement, as well as, monitor, expand and revise all items to ensure compliance.

 
Lending Activities
 
Loan Portfolio. The Company actively extends consumer loans to individuals and commercial loans to small and medium sized businesses within its primary service area. During 2010, the Company was an active residential mortgage lender; however, as of January 1, 2011 the Company ceased the origination of residential mortgage loans.  In addition, based on the requirements of the written agreement with the Bureau of Financial Institutions and the Federal Reserve, the Company is not actively seeking acquisition, development, or construction loans; however, the Company may consider such a loan on a limited basis. The Company’s commercial lending activity extends across its primary service area of Powhatan, Cumberland, Goochland, western Chesterfield and western Henrico Counties. Consistent with its focus on providing community-based financial services, the Company does not attempt to diversify its loan portfolio geographically by making significant amounts of loans to borrowers outside of its primary service area; however, a number of loans had previously been made to existing customers for vacation properties located outside of the primary service area. The principal risk associated with each of the categories of loans in the Company’s portfolio is the creditworthiness of borrowers, followed closely by the local economic environment. In an effort to manage this risk, the Bank’s policy gives loan approval limits of no more than $300,000 to the CEO, the Senior Loan and Credit Officer, and select retail officers. Loans where the total borrower exposure to the Bank is less than $3,000,000 may be approved by the Bank’s Senior Loan Committee. The Board of Directors of the Bank must approve loans where the total borrower exposure is in excess of $3,000,000. The risk associated with real estate mortgage loans and installment loans to individuals varies based upon employment levels, consumer confidence, fluctuations in value of residential real estate and other conditions that affect the ability of consumers to repay indebtedness. The risk associated with commercial, financial and agricultural loans varies based upon the strength and activity of the local economies of the Company’s primary market areas. The risk associated with real estate construction loans varies based upon the supply of and demand for the type of real estate under construction, the mortgage loan interest rate environment, and the number of speculative properties under construction. The Bank manages that risk by focusing on pre-sold or contract homes, and significantly limiting the number of “speculative” construction loans in its portfolio.  

Consumer Lending. The Bank currently offers most types of consumer demand, time and installment loans for a variety of purposes, including automobile loans, home equity lines of credit, and credit cards.  At December 31, 2010, consumer loans were $28.5 million or 11% of the Bank’s total loan portfolio.
 
Commercial Business Lending. As a full-service community bank, the Bank makes commercial loans to qualified businesses in the Bank’s market area. Commercial business loans generally have a higher degree of risk than residential mortgage loans, but have commensurately higher yields. To manage these risks, the Bank obtains appropriate collateral and monitors the financial condition of its business borrowers and the concentration of such loans in the Bank’s portfolio. Commercial business loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of its business and are generally secured by business assets, such as accounts receivable, equipment, inventory, and/or real estate. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself; in addition, the collateral for secured commercial business loans may depreciate over time.  At December 31, 2010, commercial business loans were $55.5 million or 21% of the Bank’s total loan portfolio.

Commercial Mortgage Loans. The Bank does not actively seek permanent commercial mortgage loans on income-producing properties such as apartments, shopping centers, hotels and office buildings. However, any such requests from Bank customers concerning properties in the Bank’s established trade area may be considered on a shorter term basis.
 
Real Estate Construction Lending. In general, the Bank does not actively solicit construction loans on income-producing properties such as apartments, shopping centers, hotels and office buildings. However, any such requests from Bank customers concerning properties in the Bank’s established trade area may be considered.  At December 31, 2010, real estate construction loans were $51.0 million or 20% of the Bank’s total loan portfolio.
 
The large majority of the Bank’s construction loans are to experienced builders. Such loans normally carry an interest rate of 0% to 1.5% over the prime bank lending rate, adjusted daily with a floor (minimum) rate established at loan inception. Construction lending entails significant risk as compared with residential mortgage lending. Construction loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of the home under construction. To minimize risks associated with construction lending, the Bank, as a general rule, limits loan amounts to 80.0% of appraised value on homes, and performs or causes to be performed, periodic inspections of the construction to ensure there are sufficient undisbursed loan proceeds in order to complete the building, in addition to its usual credit analysis of its borrowers. The Bank always obtains a first lien on the property as security for its construction loans.

Residential Mortgage Loans. During 2010, the Company was an active residential mortgage lender; however, as of January 1, 2011, the Bank ceased the origination of residential mortgage loans.  The Company entered into an agreement with a third party mortgage originator to rent space within the branches. The Company may refer a customer to the third party for any residential mortgage origination needs.  The Company has no commitment or obligation to the third party to refer its customers and does not receive any origination fees.  In addition, the Company has no obligation to the customer for any residential mortgage loan originated with the third party.  The Company

expects to maintain this status for the foreseeable future.  Management continues to actively monitor loan activity to determine the future strategic decision.  At December 31, 2010, residential mortgage loans were $126.4 million or 48% of the Bank’s total loan portfolio.

Historically, residential mortgage loans were made in amounts generally up to 80.0% of the appraised value of the property pledged as security for the loan. Most residential mortgage loans were underwritten using specific qualification guidelines that were intended to assure that such loans may be eligible for sale into the secondary mortgage market at a later point in time. The Bank generally required an appraisal by a licensed outside appraiser for all loans secured by real estate. The Bank required that the borrower obtain title, fire and casualty insurance coverage in an amount equal to the loan amount and in a form acceptable to the Bank. The Bank originated residential mortgage loans that were sold in the secondary market, or were carried in the Bank’s loan portfolio. These loans were generally either three-year, or five-year adjustable rate mortgages (“ARMs”) or fifteen to thirty year fixed rate mortgages. As a general rule, the majority of all permanent owner occupied residential mortgages made for the Bank’s own portfolio were made as three-year and five-year ARMs where the interest rate resets based on an index every three or five years as the case may be. The Bank does not offer ARM loans with “teaser” interest rates. The remainder of loans were traditional fifteen and thirty year amortized mortgages.
 
The Bank’s ARMs generally are subject to interest rate adjustment limitations of 2.0% per each three or five year period and 6.0% over the life of the loan. All changes in the interest rate are based on the movement of an external index contractually agreed to by the Bank and the borrower at the time the loan is originated.
 
There are risks to the Bank resulting from increased costs to a borrower as a result of the periodic repricing mechanisms of these loans. Despite the benefits of ARMs to an institution’s asset/liability management, they may pose additional risks, primarily because as interest rates rise, the underlying payments by the borrower rise, increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates.
 
The Bank charged origination fees on its residential mortgage loans. These fees varied among loan products and with market conditions. Generally such fees were from 0.25% to 2.0% of the loan principal amount. In addition, the Bank charged fees to its borrowers to cover the cost of appraisals, credit reports and certain expenses related to the documentation and closing of loans.

Competition
 
Based on FDIC deposit statistics as of June 30, 2010, the Bank has a dominant position in both Powhatan and Cumberland Counties with greater than 50% and 75% of the deposits, respectively, in each locality. However, in both Chesterfield and Henrico Counties, the Bank encounters stronger competition for its banking services from large banks and other community banks located in the Richmond metropolitan area. In addition, financial companies, mortgage companies, credit unions and savings and loan associations also compete with the Bank for loans and deposits. The Bank must also compete for deposits with money market mutual funds that are marketed nationally. Many of the Bank’s competitors have substantially greater resources than the Bank. The internet is also providing an increasing amount of price-oriented competition, which the Bank anticipates to become more intense. The success of the Bank in the past and its plans for success in the future is dependent upon providing superior customer service and convenience.
 
Employees
 
The Company and the Bank had 79 full-time and 15 part-time employees at December 31, 2010.  Employee relations have been and continue to be good. The Bank sponsors a qualified discretionary Profit Sharing/Retirement Plan combined with a qualified 401(k) Plan, for its employees. The Company did not make a profit-sharing contribution in 2009 or 2010, and effective November 1, 2010 the Company suspended employer contributions to the 401K plan. In addition, the Company subsidizes a short-term disability plan, group term life insurance, and group medical, dental, and vision insurance.
 
Regulation and Supervision
 
General. As a bank holding company, the Company is subject to regulation under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). Under the BHCA, a bank holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company


without the prior approval of the Federal Reserve Board. The BHCA also generally limits the activities of a bank holding company to that of banking, managing or controlling banks, or any other activity, which is determined to be so closely related to banking or to managing or controlling banks that an exception is allowed for those activities.
 
As a state-chartered commercial bank, the Bank is subject to regulation, supervision and examination by the Virginia State Corporation Commission’s Bureau of Financial Institutions. It also is subject to regulation, supervision and examination by the Federal Reserve Board. State and federal law also governs the activities in which the Bank engages the investments that it makes and the aggregate amount of loans that may be granted to one borrower. Various consumer and compliance laws and regulations also affect the Bank’s operations.
 
The earnings of the Company’s subsidiaries, and therefore the earnings of the Company, are affected by general economic conditions, management policies, changes in state and federal legislation and actions of various regulatory authorities, including those referred to above. The following description summarizes the significant state and federal laws to which the Company and the Bank are subject. To the extent that statutory or regulatory provisions or proposals are described, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals.
 
Payment of Dividends. The Company is a legal entity separate and distinct from our subsidiary Bank. The Company is organized under the Virginia Stock Corporation Act, which has restrictions prohibiting the payment of dividends if after giving effect to the dividend payment, the Company would not be able to pay its debts as they become due in the usual course of business, or if the Company’s total assets would be less than the sum of its total liabilities plus the amount that would be required, if the Company were to be dissolved, to satisfy the preferential rights upon dissolution of any preferred shareholders.
 
The majority of the Company’s revenue results from dividends paid to the Company by the Bank. The Bank is subject to laws and regulations that limit the amount of dividends that it can pay without permission from its primary regulator, the Federal Reserve. In addition, both the Company and the Bank are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums. Banking regulators have indicated that banking organizations should generally pay dividends only if the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. During the year ended December 31, 2010, the Bank declared and paid no dividends to the Company.

In connection with our participation in the Capital Purchase Program established by the U.S. Department of the Treasury (the "Treasury") under the Emergency Economic Stabilization Act of 2008 ("EESA"), we issued preferred stock to the Treasury on January 30, 2009. The Preferred Stock is in a superior ownership position compared to common stock. Dividends must be paid to the preferred stockholder before they can be paid to the common stockholders. In addition, prior to January 30, 2012, unless the Company has redeemed the Preferred Stock or the Treasury has transferred the Preferred Stock to a third party, the consent of the Treasury will be required for the Company to increase its common stock dividend or repurchase its common stock or other equity or capital securities, other than in certain circumstances specified in the Purchase Agreement. If the dividends on the Preferred Stock have not been paid for an aggregate of six (6) quarterly dividend periods or more, whether or not consecutive, the Company's authorized number of directors will be automatically increased by two (2) and the holders of the Preferred Stock will have the right to elect those directors at the Company's next annual meeting or at a special meeting called for that purpose; these two directors will be elected annually and will serve until all accrued and unpaid dividends for all past dividend periods have been declared and paid in full.

The Company has entered into a written agreement with the Virginia Bureau of Financial Institutions and the Federal Reserve and as a result is not able to make any distributions on its Preferred Stock, any interest payments on its trust preferred securities or declare any common dividends without prior approval from the Bureau of Financial Institutions and the Federal Reserve.  As of December 31, 2010, the Company has not paid dividends on its Preferred Stock for four quarterly dividend periods and, therefore;  is close to having to increase its number of directors as indicated above.

Insurance of Accounts and Regulation by the FDIC. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to the limits set forth under applicable law. The deposits of the Bank are subject to the deposit insurance assessments of the Bank Insurance Fund (“BIF”) of the FDIC.
 
The FDIC is authorized to prohibit any BIF-insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the respective insurance fund. Also, the FDIC may initiate enforcement actions against banks, after first giving the institution’s primary regulatory authority an opportunity to take such action. The FDIC may terminate the deposit insurance of any depository institution if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed in writing by the FDIC. It also may suspend deposit insurance during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. Management is not aware of any existing circumstances that could result in termination of any Bank’s deposit insurance.
 
Capital. The Federal Reserve Board has issued risk-based and leverage capital guidelines applicable to banking organizations that it supervises. Under the risk-based capital requirements, the Company and the Bank are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must be composed of common equity, retained earnings, qualifying perpetual preferred stock and minority interests in common equity accounts of consolidated subsidiaries, less certain intangibles (“Tier 1 capital”). The remainder may consist of specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of loan loss allowance and pre-tax net unrealized holding gains on certain equity securities (“Tier 2 capital,” which, together with Tier 1 capital, composes “total capital”).
  
In addition, each of the federal banking regulatory agencies has established minimum leverage capital requirements for banking organizations. Under these requirements, banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%, subject to federal bank regulatory evaluation of an organization’s overall safety and soundness.
 
The risk-based capital standards of the Federal Reserve Board explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by the agency in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy.

 On December 17, 2003, Central Virginia Bankshares, Inc. issued a $5 million debenture to its single purpose capital trust subsidiary, which in turn issued $5 million in trust-preferred securities. With the proceeds of this issuance, the Company then made a $5 million capital injection to its principal subsidiary, Central Virginia Bank.

The Company, on January 30, 2009, as part of the Capital Purchase Program, entered into a Letter Agreement and Securities Purchase Agreement—Standard Terms (collectively, the “Purchase Agreement”) with the Treasury, pursuant to which the Company sold (i) 11,385 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $1.25 per share, having a liquidation preference of $1,000 per share (the “Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 263,542 shares of the Company’s common stock, par value $1.25 per share (the “Common Stock”), at an initial exercise price of $6.48 per share, subject to certain anti-dilution and other adjustments, for an aggregate purchase price of $11,385,000 in cash.
 
American Recovery and Reinvestment Act of 2009. The ARRA was enacted on February 17, 2009. The ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, the ARRA imposed certain executive compensation and corporate governance obligations on all current and future Capital Purchase Program recipients, including the Company, until the institution has redeemed the preferred stock, which Capital Purchase Program recipients are permitted to do subject to approval of its primary federal regulator.
 
The ARRA amends Section 111 of the EESA to require the Secretary of the Treasury (the “Secretary”) to adopt standards with respect to executive compensation and corporate governance for Capital Purchase Program recipients. The standards required include, in part, (1) prohibitions on making golden parachute payments to senior executive officers and the next five most highly-compensated employees during such time as any obligation arising from financial assistance provided under the Capital Purchase Program remains outstanding (the “Restricted Period”), (2) prohibitions on paying or accruing bonuses or other incentive awards for certain senior executive officers and employees, except for awards of long-term restricted stock with a value equal to no greater than 1/3 of the subject employee’s annual compensation that do not fully vest during the Restricted Period or unless such compensation is pursuant to a valid written employment contract prior to February 11, 2009, (3) requirements that Capital Purchase Program participants provide for the recovery of any bonus or incentive compensation paid to senior executive officers and the next 20 most highly-compensated employees based on statements of earnings, revenues, gains or other criteria later found to be materially inaccurate, and (4) a review by the Secretary of all bonuses and other compensation paid by Capital Purchase Program participants to senior executive employees and the next 20 most highly-compensated


employees before the date of enactment of the ARRA to determine whether such payments were inconsistent with the purposes of the Act with the Secretary having authority to negotiate for reimbursement.
 
The ARRA also sets forth additional corporate governance obligations for Capital Purchase Program recipients, including standards that provide for semi-annual meetings of compensation committees of the board of directors to discuss and evaluate employee compensation plans in light of an assessment of any risk posed from such compensation plans. Capital Purchase Program recipients are further required by the ARRA to have in place company-wide policies regarding excessive or luxury expenditures, permit non-binding shareholder “say-on-pay” proposals to be included in proxy materials, as well as require written certifications by the chief executive officer and chief financial officer with respect to compliance.
 
Other Safety and Soundness Regulations. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event that the depository institution is insolvent or is in danger of becoming insolvent. For example, under the requirements of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so otherwise. In addition, the “cross-guarantee” provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC as a result of the insolvency of commonly controlled insured depository institutions or for any assistance provided by the FDIC to commonly controlled insured depository institutions in danger of failure. The FDIC may decline to enforce the cross-guarantee provision if it determines that a waiver is in the best interests of the deposit insurance funds. The FDIC’s claim for reimbursement under the cross guarantee provisions is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and nonaffiliated holders of subordinated debt of the commonly controlled insured depository institutions.
 
The federal banking agencies also have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institution in question is well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized, as defined by the law. As of December 31, 2010, the Company and the Bank were classified as adequately capitalized.
 
State banking regulators also have broad enforcement powers over the Bank, including the power to impose fines and other civil and criminal penalties, and to appoint a conservator.
 
The Bank Secrecy Act.  Under the Bank Secrecy Act (“BSA”), a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction.  Financial institutions are generally required to report cash transactions involving more than $10,000 to the United States Treasury.  In addition, financial institutions are required to file suspicious activity reports for transactions that involve more than $5,000 for known suspects, $25,000 for unknown suspects when the financial institution knows, suspects or has reason to suspect, involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose.  The USA PATRIOT Act of 2001, enacted in response to the September 11, 2001 terrorist attacks, requires bank regulators to consider a financial institution’s compliance with the BSA when reviewing applications from a financial institution.  As part of its BSA program, the USA PATRIOT Act also requires a financial institution to implement customer identification procedures when opening accounts for new customers and to review lists of individuals and entities that are prohibited from opening accounts at financial institutions.
 
Interstate Banking and Branching. Current federal law authorizes interstate acquisitions of banks and bank holding companies without geographic limitation. Effective June 1, 1997, a bank headquartered in one state was authorized to merge with a bank headquartered in another state, as long as neither of the states had opted out of such interstate merger authority prior to such date. After a bank has acquired a branch in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired branches under applicable federal or state law.
 
Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act of 1999 (the “Act”) covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies. The following description summarizes some of its significant provisions.
 
The Act permits unrestricted affiliations between banks and securities firms. The Act also permits bank holding companies to elect to become financial holding companies. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, brokerage, investment and merchant banking; and insurance


underwriting, sales and brokerage activities. In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed, and have at least a satisfactory Community Reinvestment Act rating.
 
The Act provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in certain areas identified in the Act. The Act directs the federal bank regulatory agencies to adopt insurance consumer protection regulations that apply to sales practices, solicitations, advertising and disclosures.
 
The Act adopts a system of functional regulation under which the Federal Reserve Board is confirmed as the umbrella regulator for financial holding companies, but financial holding company affiliates are to be principally regulated by functional regulators such as the FDIC for state nonmember bank affiliates, the Securities and Exchange Commission for securities affiliates and state insurance regulators for insurance affiliates. The Act repeals the broad exemption of banks from the definitions of “broker” and “dealer” for purposes of the Securities Exchange Act of 1934, as amended, but identifies a set of specific activities, including traditional bank trust and fiduciary activities, in which a bank may engage without being deemed a “broker”, and a set of activities in which a bank may engage without being deemed a “dealer”. The Act also makes conforming changes in the definitions of “broker” and “dealer” for purposes of the Investment Company Act of 1940, as amended, and the investment Advisers Act of 1940, as amended.
 
The Act contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. The Act provides that, except for certain limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The Act also provides that the states may adopt customer privacy protections that are stricter than those contained in the Act. The Act also makes a criminal offense, except in limited circumstances, obtaining or attempting to obtain customer information of a financial nature by fraudulent or deceptive means.

Dodd-Frank Act.  In July 2010, the Dodd-Frank Act was signed into law, incorporating numerous financial institution regulatory reforms.  Many of these reforms will be implemented over the course of 2011 and beyond through regulations to be adopted by various federal banking and securities regulatory agencies.  The Dodd-Frank Act implements far-reaching reforms of major elements of the financial landscape, particularly for larger financial institutions.  Many of its provisions do not directly impact community-based institutions like the Bank.  For instance, provisions that regulate derivative transactions and limit derivatives trading activity of federally-insured institutions, enhance supervision of “systemically significant” institutions, impose new regulatory authority over hedge funds, limit proprietary trading by banks, and phase-out the eligibility of trust preferred securities for Tier 1 capital are among the provisions that do not directly impact the Bank either because of exemptions for institutions below a certain asset size or because of the nature of  the Bank’s operations.  Provisions that could impact the Bank include the following:

 
·
FDIC Assessments. The Dodd-Frank Act changes the assessment base for federal deposit insurance from the amount of insured deposits to average consolidated total assets less its average tangible equity.  In addition, it increases the minimum size of the Deposit Insurance Fund (“DIF”) and eliminates its ceiling, with the burden of the increase in the minimum size on institutions with more than $10 billion in assets.
 
·
Deposit Insurance.  The Dodd-Frank Act makes permanent the $250,000 limit for federal deposit insurance and provides unlimited federal deposit insurance until December 31, 2012 for non-interest-bearing demand transaction accounts at all insured depository institutions.
 
·
Interest on Demand Deposits.  The Dodd- Frank Act also provides that, effective one year after the date of enactment, depository institutions may pay interest on demand deposits, including business transaction and other accounts.
 
·
Interchange Fees.  The Dodd-Frank Act requires the Federal Reserve to set a cap on debit card interchange fees charged to retailers.  While banks with less than $10 billion in assets, such as the Bank, are exempted from this measure, it is likely that, if this measure is implemented, all banks could be forced by market pressures to lower their interchange fees or face potential rejection of their cards by retailers.
 
·
Consumer Financial Protection Bureau.  The Dodd-Frank Act centralizes responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing federal consumer protection laws,


 
although banks below $10 billion in assets will continue to be examined and supervised for compliance with these laws by their federal bank regulator.
 
·
Mortgage Lending.  New requirements are imposed on mortgage lending, including new minimum underwriting standards, prohibitions on certain yield-spread compensation to mortgage originators, special consumer protections for mortgage loans that do not meet certain provision qualifications, prohibitions and limitations on certain mortgage terms and various new mandated disclosures to mortgage borrowers.
 
·
Holding Company Capital Levels.  Bank regulators are required to establish minimum capital levels for holding companies that are at least as stringent as those currently applicable to banks.  In addition, all trust preferred securities issued after May 19, 2010 will be counted as Tier 2 capital, but the Company’s currently outstanding trust preferred securities will continue to qualify as Tier 1 capital.
 
·
De Novo Interstate Branching.  National and state banks are permitted to establish de novo interstate branches outside of their home state, and bank holding companies and banks must be well-capitalized and well managed in order to acquire banks located outside their home state.
 
·
Transactions with Affiliates. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.
 
·
Transactions with Insiders. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivative transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.
 
·
Corporate Governance.  The Dodd-Frank Act includes corporate governance revisions that apply to all public companies, not just financial institutions, including with regard to executive compensation and proxy access to shareholders.

Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, and their impact on the Company or the financial industry is difficult to predict before such regulations are adopted.

Regarding capital requirements.  The Dodd-Frank Act (contains a number of provisions dealing with capital adequacy of insured depository institutions and their holding companies, which may result in more stringent capital requirements.  Under the Collins Amendment to the Dodd-Frank Act, federal regulators have been directed to establish minimum leverage and risk-based capital requirements for, among other entities, banks and bank holding companies on a consolidated basis.  These minimum requirements can’t be less than the generally applicable leverage and risk-based capital requirements established for insured depository institutions nor quantitatively lower than the leverage and risk-based capital requirements established for insured depository institutions that were in effect as of July 21, 2010.  These requirements in effect create capital level floors for bank holding companies similar to those in place currently for insured depository institutions.  The Collins Amendment also excludes trust preferred securities issued after May 19, 2010 from being included in Tier 1 capital unless the issuing company is a bank holding company with less than $500 million in total assets.  Trust preferred securities issued prior to that date will continue to count as Tier 1 capital for bank holding companies with less than $15 billion in total assets, and such securities will be phased out of Tier 1 capital treatment for bank holding companies with over $15 billion in total assets over a three-year period beginning in 2013.  Accordingly, our trust preferred securities will continue to qualify as Tier 1 capital.

Regarding FDIC insurance and assessments.  The FDIC is required to maintain a designated minimum ratio of the DIF to insured deposits in the United States. In July 2010, the Dodd Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") was signed into law. The Dodd-Frank Act requires the FDIC to assess insured depository institutions to achieve a DIF ratio of at least 1.35 percent by September 30, 2020. The FDIC has recently adopted new regulations that establish a long-term target DIF ratio of greater than two percent. As a result of the ongoing instability in the economy and the failure of other U.S. depository institutions, the DIF ratio is currently below the required targets and the FDIC has adopted a restoration plan that will result in substantially higher deposit insurance assessments for all depository institutions over the coming years. Deposit insurance assessment rates are subject to change by the FDIC and will be impacted by the overall economy and the stability of the banking industry as a whole.

Pursuant to the Dodd-Frank Act, FDIC insurance coverage limits were permanently increased to $250,000 per customer. The Dodd-Frank Act also provides for unlimited FDIC insurance coverage for noninterest-bearing demand deposit accounts for a two year period beginning on December 31, 2010 and ending on December 31, 2010.
 
The Dodd-Frank Act also changed the methodology for calculating deposit insurance assessments by changing the assessment base from the amount of an insured depository institution's domestic deposits to its total assets minus tangible equity. On February 7, 2011, the FDIC issued a new regulation implementing revisions to the assessment system mandated by the Dodd-Frank Act. The new regulation will be effective April 1, 2011 and will be reflected in the June 30, 2011 FDIC fund balance and the invoices for assessments due September 30, 2011. As a result of the new regulations, we expect to incur annual deposit insurance assessments that are higher than before the financial crisis. While the burden on replenishing the DIF will be placed primarily on institutions with assets of greater than $10 billion, any future increases in required deposit insurance premiums or other bank industry fees could have a significant adverse impact on our financial condition and results of operations.

Regarding transactions with insiders.  The Dodd-Frank Act also provides that banks may not “purchase an asset from, or sell an asset to” a bank insider (or their related interests) unless (i) the transaction is conducted on market terms between the parties, and (ii) if the proposed transaction represents more than 10 percent of the capital stock and surplus of the bank, it has been approved in advance by a majority of the bank’s non-interested directors.

Regarding debit card interchange fees.  One provision of the Dodd-Frank Act requires the Federal Reserve to set a cap on debit card interchange fees charged to retailers.  In December 2010, the Federal Reserve proposed capping the fee at 12 cents per debit card transaction, which is well below the average that banks currently charge.  While banks with less than $10 billion in assets (such as the Bank) are exempted from this measure, as a practical matter we expect that, if this measure is implemented, all banks could be forced by market pressures to lower their interchange fees or face potential rejection of their cards by retailers.  As a result, our debit card revenue could be adversely impacted if the interchange cap is implemented.

 
RISK FACTORS
 
We are subject to various risks, including the risks described below.  Our business, results of operations and financial condition could be materially and adversely affected by any of these risks or additional risks not presently known or that we currently deem immaterial.

General economic conditions in our market area could adversely affect us.
 
We are affected by the general economic conditions in the local markets in which we operate. Our market has experienced a significant downturn in which we have seen falling home prices, rising foreclosures and an increased level of commercial and consumer delinquencies.  If economic conditions in our market do not improve, we could experience any of the following consequences, each of which could further adversely affect our business:

·      demand for our products and services could decline;
·      loan losses may increase; and
·      problem assets and foreclosures may increase.

We could experience further adverse consequences in the event of a prolonged economic downturn, which could impact collateral values or cash flows of the borrowing businesses and, as a result, our primary source of repayment could be insufficient to service their debt. Future economic conditions in our market will depend on factors outside of our control such as political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government, military and fiscal policies and inflation.

Our concentration in loans secured by real estate could, as a result of adverse market conditions, increase credit losses which could adversely impact earnings.
 
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market area, which could result in adverse consequences to us in the event of a prolonged economic downturn in our market. As of December 31, 2010, approximately 77% of our loans had real estate as a primary or secondary component of collateral.  A further significant decline in real estate values in our market would mean that the collateral for many of our loans would provide less security. As a result, we would be more likely to suffer losses on defaulted loans because our ability to fully recover on defaulted loans by selling the real estate collateral would be diminished. In addition, a number of our loans are dependent on successful completion of real estate projects and demand for homes, both of which could be affected adversely by a decline in the real estate markets.  We could experience credit losses that adversely affect our earnings.

Should our allowance for loan losses become inadequate, our results of operations may be adversely affected.
 
Our earnings are significantly affected by our ability to properly originate, underwrite and service loans.  In addition, we maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses within our loan portfolio. We could sustain losses if we incorrectly assess the creditworthiness of our borrowers or fail to detect or respond to deterioration in asset quality in a timely manner.  At December 31, 2010, our non-performing loans were $39.0 million, an increase of $15.2 million from $23.8 million at December 31, 2009.  Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with us.  During fiscal 2010, our provision for loan losses was $7.8 million and our loan loss allowance to total loans was 4.03% at December 31, 2010.

The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. Rapidly growing loan portfolios are, by their nature, unseasoned. As a result, estimating loan loss allowances is more difficult, and may be more susceptible to changes in estimates, and to losses exceeding estimates, than more seasoned portfolios. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in the loan portfolio, it cannot fully predict such losses or that the loss allowance will be adequate in the future. Additional problems with asset quality could cause our interest income and net interest margin to decrease and our provisions for loan losses to increase further, which could adversely affect our results of operations and financial condition.
 
Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of management. Any increase in the amount of the provision or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results.

We have entered into a written agreement with the Virginia Bureau of Financial Institutions and the Federal Reserve Bank of Richmond, which will require us to dedicate a significant amount of resources to comply with the agreement.

We entered into a written agreement with the Bureau of Financial Institutions and Federal Reserve on June 30, 2010. Among other things, the written agreement requires us to significantly exceed the capital level required to be classified as “well capitalized,” to develop and implement written plans to improve our credit risk management and compliance systems, oversight functions, operating and financial management and capital plans. While subject to the written agreement, we expect that our management and board of directors will be required to focus considerable time and attention on taking corrective actions to comply with its terms. We also will hire third party consultants and advisors to assist us in complying with the written agreement, which could increase our non-interest expense and reduce our earnings.  Our expense associated with third party consultants in relation to complying with the written agreement was $527 thousand for the year ended December 31, 2010.

The Bank has complied with the initial requirements of the written agreement, including submitting plans to significantly exceed the capital level required to be classified as “well capitalized”, improve corporate governance, strengthen board oversight of management and operations, strengthen credit risk management and administration, and improve asset quality.  The Bank continues to address the requirements of the written agreement, as well as, monitor, expand and revise all items to ensure compliance.

There also is no guarantee that we will successfully address the Bureau of Financial Institution’s and Federal Reserve’s concerns in the written agreement or that we will be able to comply with it. If we do not comply with the written agreement, we could be subject to civil monetary penalties, further regulatory sanctions and/or other regulatory enforcement actions, including, ultimately, a regulatory takeover of the Bank.

An inability to improve our regulatory capital position could adversely affect our operations.

At December 31, 2010, we were classified as “adequately capitalized” for regulatory capital purposes.  Until we become “well capitalized” for regulatory capital purposes, we cannot renew or accept brokered deposits without prior regulatory approval and we may not offer interest rates on our deposit accounts that are significantly higher than the average rates in our market area. As a result, it may be more difficult for us to attract new deposits as our existing brokered deposits mature and do not rollover and to retain or increase non-brokered deposits. If we are not able to attract new deposits, our ability to fund our loan portfolio may be adversely affected. In addition, we will pay higher insurance premiums to the FDIC, which will reduce our earnings.

We may need to raise additional capital.

Our written agreement with the Virginia Bureau of Financial Institutions and the Federal Reserve will require us to develop a written plan to maintain sufficient capital, and we may have to sell additional securities in order to generate additional capital.  We may seek to raise capital through offerings of our common stock, preferred stock, securities convertible into common stock, or rights to acquire such securities or our common stock. Under our articles of incorporation, we have additional authorized shares of common stock and preferred stock that we can issue from time to time at the discretion of our board of directors, without further action by the shareholders, except where shareholder approval is required by law or the Nasdaq Stock Market. The issuance of any additional shares of common stock, preferred stock or convertible securities could be substantially dilutive to shareholders of our common stock, and the market price of our common stock could decline as a result of any such sales.  Thus, our shareholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings.

We may be subject to prompt corrective action by our regulators if our risk based capital ratio declines below 8%.

Section 38 of the Federal Deposit Insurance Act requires insured depository institutions and federal banking regulators to take certain actions promptly to resolve capital deficiencies at insured depository institutions.  Section 38 establishes mandatory and discretionary  restrictions on any insured depository institution that fails to remain at least adequately capitalized, which could include:  submissions and implementations of acceptable capital plans, restrictions on the payment of dividends and certain management fees, increased supervisory monitoring, restrictions as to asset growth, branching and new business lines without regulatory approval, restriction of senior officer compensation, placement into receivership, restriction of entering into certain material transactions, restriction of extending credit, restriction of making any material changes in accounting  methods, and restrictions as to undertaking covered transactions.


Difficult market conditions have adversely affected our industry.
 
Dramatic declines in the housing market, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. These write-downs, initially of asset-backed securities but spreading to other securities and loans, have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets has adversely affected our business and results of operations. Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry.

Our small-to-medium sized business target market may have fewer financial resources to weather a downturn in the economy.

We target our commercial development and marketing strategy primarily to serve the banking and financial services needs of small and medium sized businesses. These businesses generally have less capital or borrowing capacity than larger entities. If general economic conditions negatively impact this major economic sector in the markets in which we operate, our results of operations and financial condition may be adversely affected.

Changes in market interest rates could affect our cash flows and our ability to successfully manage our interest rate risk.
 
Our profitability and financial condition depend to a great extent on our ability to manage the net interest margin, which is the difference between the interest income earned on loans and investments and the interest expense paid for deposits and borrowings. The amounts of interest income and interest expense are principally driven by two factors; the market levels of interest rates, and the volumes of earning assets or interest bearing liabilities. The management of the net interest margin is accomplished by our Asset Liability Management Committee. Short term interest rates are highly sensitive to factors beyond our control and are effectively set and managed by the Federal


Reserve, while longer term rates are generally determined by the market based on investors’ inflationary expectations. Thus, changes in monetary and or fiscal policy will affect both short term and long term interest rates which in turn will influence the origination of loans, the prepayment speed of loans, the purchase of investments, the generation of deposits and the rates received on loans and investment securities and paid on deposits or other sources of funding. The impact of these changes may be magnified if we do not effectively manage the relative sensitivity of our earning assets and interest bearing liabilities to changes in market interest rates. We generally attempt to maintain a neutral position in terms of the volume of earning assets and interest bearing liabilities that mature or can re-price within a one year period in order that we may maintain the maximum net interest margin; however, interest rate fluctuations, loan prepayments, loan production and deposit flows are constantly changing and greatly influence this ability to maintain a neutral position.
 
Generally, our earnings will be more sensitive to fluctuations in interest rates the greater the difference between the volume of earning assets and interest bearing liabilities that mature or are subject to re-pricing in any period. The extent and duration of this sensitivity will depend on the cumulative difference over time, the velocity and direction of interest rate changes, and whether we are more asset sensitive or liability sensitive. Additionally, the Asset Liability Management Committee may desire to move our position to more asset sensitive or more liability sensitive depending upon their expectation of the direction and velocity of future changes in interest rates in an effort to maximize the net interest margin. Should we not be successful in maintaining the desired position, or should interest rates not move as anticipated, our net interest margin may be negatively impacted.

Significant market declines and/or the absence of normal orderly purchases and sales may adversely affect the “market” valuations of our investment portfolio securities.
 
The capital and credit markets have been experiencing volatility and disruption for more than 12 months. Recently, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. We could be subject to further significant and material depreciation of our investment portfolio securities if we utilize only previous market sales prices in a disorderly or nonfunctioning market, where the only transactions have been distressed or forced sales. We will rely on alternative valuation methods in accordance with guidance from the FASB and other regulatory agencies such as the Federal Reserve and the Securities and Exchange Commission. This market valuation process could significantly reduce our capital and/or profitability. If current levels of market disruption and volatility continue or worsen, there can be no assurance that the declines in market value associated with these disruptions will not result in other-than-temporary impairments of these assets, which could have a material adverse effect on our net income and capital levels.
   
Our future success is dependent on our ability to effectively compete in the face of substantial competition from other financial institutions in our primary markets.
 
We encounter significant competition for deposits, loans and other financial services from banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions in our market area. A number of these banks and other financial institutions are significantly larger than us and have substantially greater access to capital and other resources, larger lending limits, more extensive branch systems, and may offer a wider array of banking services. To a limited extent, we compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies and governmental organizations any of which may offer more favorable financing rates and terms than us. Most of these non-bank competitors are not subject to the same extensive regulations that govern us. As a result, these non-bank competitors may have advantages in providing certain services. This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition.
 
The soundness of other financial institutions could adversely affect us.
 
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
 


Our continued success is largely dependent on key management team members.
 
We are a customer-focused and relationship-driven organization. Future growth is expected to be driven by a large part in the relationships maintained with customers. While we have assembled an experienced and talented senior management team, maintaining this team, while at the same time developing other managers in order that management succession can be achieved, is not assured. The unexpected loss of key employees could have a material adverse effect on our business and may result in lower revenues or reduced earnings.
 
Our inability to successfully implement our strategic plans could adversely impact earnings as well as our overall financial condition.
 
A key aspect of our long-term business strategy is our continued growth and expansion.  However, we expect to curtail asset growth and focus on improving our profitability until our capital levels are restored to acceptable levels.  It is uncertain when, or if, we will be able to successfully increase our capital levels and resume our long-term growth strategy.

Even if we are able to restore our capital levels, we may not be able to successfully implement our strategic plans and manage its growth if we are unable to identify attractive markets, locations or opportunities for expansion in the future. Successful management of increased growth is contingent upon whether we can maintain appropriate levels of capital to support our growth, maintain control over growth in expenses, maintain adequate asset quality, and successfully integrate into the organization, any businesses acquired.  In the event that we do open new branches or acquire existing branches or banks, we expect to incur increased personnel, occupancy and other operating expenses. In the case of branch franchise expansion, we must absorb these higher expenses as we begin to generate new deposits. There is a further time lag involved in redeploying the new deposits into attractively priced loans and other higher yielding earning assets. Thus, we may not be able to implement our long-term growth strategy, and our plans to branch could depress earnings in the short run, even if we are able to efficiently execute our branching strategy.
  
Changes in accounting standards could impact reported earnings.

The accounting, disclosure, and reporting standards set by the Financial Accounting Standards Board, Securities and Exchange Commission and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation and presentation of the our consolidated financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.
 
Significant changes in legislation and or regulations could adversely impact us.
 
We are subject to extensive supervision, regulation, and legislation by both state and federal banking authorities. Many of the regulations we are governed by are intended to protect depositors, the public, or the insurance funds maintained by the Federal Deposit Insurance Corporation, not shareholders. Banking regulations affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business. These requirements may constrain our rate of growth, and changes in regulations could adversely affect it. The burden imposed by federal and state regulations may place banks in at competitive disadvantage compared to less regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect our ability to operate profitably.

The trading volume in our common stock is lower than that of other financial services companies.

Although our common stock is traded on the Nasdaq Capital Market, the trading volume in our common stock is lower than that of other financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall.

Our ability to pay dividends is limited and we suspended payment of dividends during 2010.  As a result, capital appreciation, if any, of our common stock may be your sole opportunity for gains on your investment for the foreseeable future.

Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient capital, and by contractual restrictions under the agreement with the U.S. Treasury in connection with the issuance of our Series A Preferred Stock under the TARP


Capital Purchase Program. The ability of our banking subsidiary to pay dividends to us is limited by its obligations to maintain sufficient capital and by other general restrictions on its dividends that are applicable to our banking subsidiary. If we do not satisfy these regulatory requirements, we are unable to pay dividends on our common stock. Holders of our common stock are only entitled to receive such dividends as our board of directors may declare out of funds legally available for such payments. In the first quarter of 2010, we suspended payment of dividends on our common stock. In addition, we are subject to regulatory restrictions that do not permit us to declare or pay any dividend without the prior written approval of our banking regulators. Although we can seek to obtain a waiver of this prohibition, banking regulators may choose not to grant such a waiver, and we would not expect to be granted a waiver or be released from this obligation until our financial performance improves significantly. Therefore, we may not be able to resume payments of dividends in the future.

Government measures to regulate the financial industry, including the recently enacted Dodd-Frank Act, subject us to increased regulation and could adversely affect us.

As a financial institution, we are heavily regulated at the state and federal levels.  As a result of the financial crisis and related global economic downturn that began in 2007, we have faced, and expect to continue to face, increased public and legislative scrutiny as well as stricter and more comprehensive regulation of our financial services practices.  In July 2010, the Dodd-Frank Act was signed into law.  The Dodd-Frank Act includes significant changes in the financial regulatory landscape and will impact all financial institutions, including the Company and the Bank.  Many of the provisions of the Dodd-Frank Act have begun to be or will be implemented over the next several months and years and will be subject both to further rulemaking and the discretion of applicable regulatory bodies.  Because the ultimate impact of the Dodd-Frank Act will depend on future regulatory rulemaking and interpretation, we cannot predict the full effect of this legislation on our businesses, financial condition or results of operations.  Among other things, the Dodd-Frank Act and the regulations implemented thereunder could limit debit card interchange fees, increase FDIC assessments, impose new requirements on mortgage lending, and establish more stringent capital requirements on bank holding companies.  As a result of these and other provisions in the Dodd-Frank Act, we could experience additional costs, as well as limitations on the products and services we offer and on our ability to efficiently pursue business opportunities, which may adversely affect our businesses, financial condition or results of operations.

UNRESOLVED STAFF COMMENTS

None.
 
PROPERTIES
 
The current corporate center office of the Company and the Bank is a two-story brick building with a fully finished basement, built in 1994 with approximately 15,000 square feet of office space. It houses deposit and loan operations, information technology and data center, accounting and finance, human resources and training, and general facilities services, and some executive offices. It is located at 2036 New Dorset Road in Powhatan County. The current main office was constructed in 2004 and occupied in June 2005. It is a two story brick building with 16,000 square feet of office space located on a 6.95 acre tract of land at the intersection of New Dorset Road and Route 60 in Powhatan County. The main office building houses a branch, some executive offices, several retail and most all commercial, mortgage and construction loan personnel. The present new main office replaced the original main office and an adjacent branch facility at Flatrock, both of which were closed in 2005. The original main office building and land were sold in June 2006.
 
The Cartersville location, in Cumberland County, which originally opened in 1985, was replaced in mid-1994 with a one-story brick building with approximately 1,600 square feet. The Midlothian branch is located in Chesterfield County at the Village Marketplace shopping center and was built in 1988 and opened in May of that year. It is a one and one-half story building with approximately 3,000 square feet. The Flatrock branch was acquired in 1992 from the Resolution Trust Corporation with the bank assuming approximately $9.0 million in deposit liabilities of the former CorEast Federal Savings Bank. The Flatrock branch facility is located in the Village of Flat Rock across Route 60 from the Bank’s original main office, and was closed in June 2005 and is currently used for offsite record storage. In April 1993, the Bank acquired the branch facility of the former Investors Federal Savings Bank located in the Market Square Shopping Center in Brandermill in Chesterfield County, through the Resolution Trust Corporation. This one-story building contains approximately 1,600 square feet and opened for business on November 1, 1993.
 
In June 1998, the Bank completed construction of and opened a 4,800 square foot branch located on U. S. Route 60 (Anderson Highway) near the courthouse in Cumberland County, Virginia. In July 2001, the Bank acquired a one-story, 2,800 square foot, two-year old branch facility from another financial institution located on Lauderdale Drive in Wellesley in Henrico County. In December 2004, the Bank


purchased a 2,800 square foot, seven-year old branch bank building from another financial institution. This branch is located at 2500 Promenade Parkway in the Bellgrade shopping center located in the Midlothian area of Chesterfield County.
 
LEGAL PROCEEDINGS
 
There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or the Bank is a party or of which the property of the Company or the Bank is subject.
 
REMOVED AND RESERVED
 

 
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Common Stock and Dividends
 
Central Virginia Bankshares, Inc. Common Stock trades on The Nasdaq Capital Market (“Nasdaq”) under the symbol “CVBK”. The Company was a member of The Nasdaq Global Market until November 22, 2010.  As of March 25, 2011 the Company had approximately 733 shareholders of record.
 
The following table sets forth the high and low trade prices of the Company’s Common Stock on Nasdaq, based on published financial sources, and the dividends paid on the Common Stock for each calendar quarter indicated. Prior period trade prices and dividends per share have been adjusted to reflect the 5% stock dividend paid June 13, 2008 to shareholders of record May 31, 2008.
 
   
2010
   
2009
   
2008
 
   
High Trade
   
Low Trade
   
Dividends Paid
   
High Trade
   
Low Trade
   
Dividends Paid
   
High Trade
   
Low Trade
   
Dividends Paid
 
First Quarter
  $ 4.10     $ 3.25     $ -     $ 5.62     $ 3.76     $ 0.0525     $ 19.04     $ 16.68     $ 0.18  
Second Quarter
  $ 3.60     $ 1.03     $ -     $ 4.50     $ 3.45     $ 0.0525     $ 18.50     $ 15.01     $ 0.18  
Third Quarter
  $ 2.00     $ 0.81     $ -     $ 4.50     $ 3.04     $ 0.0525     $ 16.25     $ 7.50     $ 0.18  
Fourth Quarter
  $ 1.15     $ 0.80     $ -     $ 4.10     $ 2.99     $ 0.01     $ 10.51     $ 3.50     $ 0.105  
 
In the first quarter of 2010, we suspended payment of dividends on our common stock.  We currently are subject to regulatory restrictions that do not permit us to make any distributions on our Preferred Stock, any interest payments on our trust preferred securities or declare any common dividends without prior approval from our banking regulators.  We expect that we will not be permitted to declare or pay any dividends until our financial performance improves significantly.

In January 2009, we issued preferred stock to the U.S. Treasury pursuant to the TARP Capital Purchase Program.  Under the terms of the preferred stock, we are required to pay dividends on the preferred stock before they can be paid on our common stock.  We also suspended payment of dividends on our preferred stock in the first quarter of 2010, so we will be required to pay all accrued and unpaid dividends on our preferred stock before we will be able to resume payment of dividends on our common stock.
 
As a result of these regulatory and contractual restrictions on our ability to pay dividends on our common stock, we are unable to predict when we may be able to resume payment of dividends on our common stock.

When we are able to resume dividend payments, our future dividend policy will be subject to the discretion of the board of directors and will depend upon a number of factors, including future consolidated earnings, financial condition, liquidity and capital requirements of the Company and the Bank, applicable governmental regulations and policies and other factors deemed relevant by the board of directors.  Our ability to distribute cash dividends will depend primarily on the amount of cash and liquid assets held as well as the ability of the Bank to declare and pay dividends to the Company. As a state member bank, the Bank is subject to certain restrictions imposed by the reserve and


capital requirements of federal and Virginia banking statutes and regulations. Furthermore, neither the Company nor the Bank may declare or pay a cash dividend on any capital stock if it is insolvent or if the payment of the dividend would render it insolvent or unable to pay its obligations as they become due in the ordinary course of business.

For additional information on these limitations, see “Regulation and Supervision – Payment of Dividends” in Item 1 above.
 

ITEM 6.           
SELECTED FINANCIAL DATA
 
 (Dollars in Thousands Except for Per Share Data)
 
2010
   
2009
   
2008
   
2007
   
2006
 
Balance Sheet Data
 
Total Assets
  $ 409,142     $ 473,224     $ 486,268     $ 485,221     $ 437,535  
Total Deposits
    346,062       385,526       347,963       358,761       357,993  
 Loans Receivable, net
    250,925       281,490       289,609       262,937       205,618  
Stockholders' Equity
    11,025       26,219       20,308       36,864       37,086  
   
Income Statement Data
                                       
Net Interest Income
  $ 12,205     $ 12,992     $ 14,283     $ 14,811     $ 15,070  
 Provision for Loan Losses
    7,784       9,512       1,250       180       -  
 Net Interest Income After
                                       
Provision for Loan Losses
    4,421       3,480       13,033       14,631       15,070  
Non-interest Income
    4,734       3,180       3,537       3,542       4,376  
 Non-interest Expense
    14,745       20,019       31,943       13,138       12,657  
 (Loss) Income Before Income Taxes
    (5,590 )     (13,358 )     (15,372 )     5,035       6,789  
Income Taxes Expense (Benefit)
    9,661       (4,192 )     (5,748 )     1,046       1,639  
Net (Loss) Income
    (15,251 )     (9,166 )     (9,625 )     3,989       5,150  
                                         
Per  Common Share Data (1)
                                       
Net (Loss) Income – Basic
  $ (6.06 )   $ (3.74 )   $ (3.73 )   $ 1.56     $ 2.03  
           – Diluted
    (6.06 )     (3.74 )     (3.73 )     1.54       2.01  
Cash Dividends Per Common Share
    -       0.1675       0.645       0.72       0.71  
Tangible Common Equity Per Common Share
    (0.19 )     5.64       7.82       14.35       14.60  
Book Value Per Common Share
    4.20       10.01       7.82       15.06       15.33  
                                         
Ratios
                                       
 Return on Average Assets
    (3.41 %)     (1.85 %)     (1.95 )%     .87 %     1.26 %
 Return on Average Equity
    (61.58 %)     (30.18 %)     (32.45 )%     10.60 %     15.10 %
 Average Equity to Assets
    5.54 %     6.12 %     6.02 %     8.18 %     8.32 %
Dividend Payout
    - %     4.76 %     17.04 %     43.90 %     32.71 %
                                         
(1) Adjusted for 5% stock dividends paid in June 2008 and June 2006.
         

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Current Environment

Beginning in the summer of 2007, significant adverse changes in financial market conditions resulted in a deleveraging of the entire global financial system.  As part of this process, residential and commercial mortgage markets in the United States have experienced a variety of difficulties including loan defaults, credit losses and reduced liquidity.  In response to these unprecedented events, the U.S. Government has taken a number of actions to improve stability in the financial markets and encourage lending.  One such program is the Troubled Assets Relief Program, or TARP.

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (or the Dodd-Frank Act). The Dodd-Frank Act provides for new regulations on financial institutions and creates new supervisory and advisory bodies, including the new Consumer Financial Protection Bureau. The Dodd-Frank Act tasks many agencies with issuing a variety of new regulations, including rules related to mortgage origination and servicing, securitization and derivatives. As the Dodd-Frank Act has only recently been enacted and because a significant number of regulations have yet to be proposed, it is not possible for us to predict how the Dodd-Frank Act will impact our business.

 
On February 12, 2010, we notified the U.S. Department of the Treasury that our Board of Directors determined that the payment of the quarterly cash dividend of $142 thousand due during the first quarter of 2010, and subsequent quarterly payments on the Fixed Rate Cumulative Perpetual Preferred Stock, Series A, should be deferred.  The total arrearage on such preferred stock as of December 31, 2010 is $569 thousand.  This amount has been accrued for in our consolidated financial statements.

Impact of Income Tax Valuation
 
We determined that a $14.3 million valuation allowance on our deferred tax asset is required as of December 31, 2010. We decided to establish a valuation allowance during the third quarter 2010 against the deferred tax asset because it is uncertain when we will realize this asset. The valuation allowance does not impact our Tier One Capital for regulatory purposes because net deferred tax assets are already excluded from that calculation.

Factors Impacting Our Operating Results

In addition to the prevailing market conditions, we expect that the results of our operations will be affected by a number of factors and will primarily depend on, among other things, the level of our net interest income, the market value of our assets and the supply of, and demand for, commercial and residential mortgage loans, commercial real estate debt, mortgage-backed securities and other financial assets in the marketplace.  Our net interest income includes the actual payments we receive and is also impacted by the level of loans that are not accruing interest due to their delinquency level.  Our net interest income varies over time, primarily as a result of changes in interest rates, volume and levels of interest earning assets and interest paying deposits and liabilities.  Interest rates vary according to the type of asset, conditions in the financial markets, credit worthiness of our borrowers, competition and other factors, none of which can be predicted with any certainty.  Our operating results may also be impacted by credit losses in excess of the amounts that we have provided for at December 31, 2010.

Credit Risk. We may be exposed to various levels of credit risk, depending on the nature of our underlying assets.  Our Loan Committee will approve and monitor credit risk and other risks associated with our loan portfolio and our Asset Liability Committee (“ALCO”) will approve and monitor credit risk associated with our investment portfolio.  Our Board of Directors monitors credit risk through their monthly Board of Directors meetings.

Amount of Earning Assets. The amount of our earning assets, as measured by the aggregate unpaid principal balance of our loan and our investment portfolios, is a key revenue driver.  During 2010, we have strategically decreased the balances of our investment portfolio and borrowings and certificates of deposits in order to improve our capital position.  Generally, as the size of our earning assets decrease, the amount of interest income we receive decreases.  The reduction in earning assets also helps to lower interest expense as we incur less interest expense from certificates of deposits to finance the earning assets.  However, the decline in our interest income has been greater than the decrease in our interest expense which, in total, reduces our net interest income.

Changes in Market Interest Rates. With respect to our business operations, increases in interest rates, in general, may over time cause:
 
·
the interest expense associated with our borrowings to increase;
 
·
the value of our fixed rate investment securities to decline;
 
·
the interest expense associated with our variable rate deposits to increase;
 
·
coupons on our variable rate loans to reset, although on a delayed basis, to higher interest rates to the extent allowed by individual loan floors and caps; and
 
·
to the extent applicable under the terms of our assets, prepayments on our mortgage loan portfolio and mortgage-backed securities to slow thus increasing the duration of these assets.
Conversely, decreases in interest rates, in general, may over time cause:
 
·
to the extent applicable under the terms of our assets, prepayments on our mortgage loans and mortgage-backed securities to increase thus shortening the duration of these assets;
 
·
the interest expense associated with our variable rate deposits and borrowings to decrease;
 
·
the value of our fixed rate investment securities to increase; and
 
·
coupons on our adjustable-rate loans to reset, although on a delayed basis, to lower interest rates subject to interest rate floors on the individual loan.

Since changes in interest rates may significantly affect our activities, our operating results depend, in large part, upon our ability to effectively manage interest rate risks.

Results of Operations
 
For the year ended December 31, 2010, we reported a net loss of $15.3 million.  After the accrued, but unpaid dividend of $0.6 million to the Treasury on preferred stock, the net loss to common shareholders was $15.9 million.  On a per share basis, the net loss was $(6.06) per common share while the return on average assets and return on average equity was (3.41)% and (61.58)% respectively.  The loss in 2010 was primarily due to the addition of $7.8 million in provisions for future loan losses given the level of non-performing loans and a deferred tax asset valuation allowance of $14.3 million. Also impacting the loss in 2010 was a decrease of $4.4 million in interest income due to increasing non-performing loans, decreasing interest rates and a decline in interest-earning assets

Total assets declined $64.1 million at December 31, 2010 to $409.1 million from $473.2 million at December 31, 2009.  Total cash and cash equivalents increased $1.4 million to $13.9 million as total deposits decreased $39.5 million, total loans decreased $30.9 million, securities available for sale decreased $14.2 million, and total borrowings decreased $9.8 million from $57.9 million in 2009 to $48.1 million in 2010.  The decrease in deposits is primarily due to a decline in our certificates of deposit as we have continued to lower deposit interest rates.  Funds received from the sale, maturity, and calls of investment securities allowed us to pay down our borrowings by $10 million.  At December 31, 2010, the book value of a share of common stock was $(0.19) compared to $5.64 at December 31, 2009.

For the year ended December 31, 2009 we reported a net loss of $9.2 million compared to a net loss of $9.6 million reported for the year ended December 31, 2008, a decline of $0.4 million or 4.2%. The loss in 2009 was primarily due to the addition of $9.5 million in provisions for future loan losses given the level of non-performing loans and charges totaling $6.7 million in impairment losses on securities. Also impacting the loss in 2009 was a decrease of $4.1 million in interest income due to increasing non-performing loans, decreasing interest rates and the loss of over $1.0 million in income from FNMA and FHLMC preferred stock dividends which were suspended after they were placed in conservatorship in 2008.

At December 31, 2009 total assets were $473.2 million, a decrease of $13.1 million or 2.7% from $486.3 million at year end 2008. Comparing the major components of our balance sheet at year end 2009 and 2008 finds cash and funds sold were $12.5 versus $6.6 million, investment securities were $127.4 versus $145.9 million, loans were $292.3 versus $293.4 million, other assets were $49.7 versus $43.1 million, deposits were $385.5 versus $348.0 million, borrowings were $57.9 versus $115.0 million and total shareholder’s equity was $26.2 versus $20.3 million. At December 31, 2009, the book value of a share of common stock was $5.64 versus $7.82 in 2008.

Our return on average equity was (61.58)% and (30.18)% in 2010 and 2009 respectively and (32.45)% in 2008.  The return on average assets amounted to (3.41)% and (1.85)% in 2010 and 2009 respectively and (1.95)% in 2008.
 
Net Interest Income.  In 2010, our net interest income was $12.2 million compared to $13.0 million in 2009 and $14.3 million in 2008.   Interest and fees on loans decreased 9.9% in 2010 from 2009 as the amount of non-accrual loans rose from $21.7 million at December 31, 2009 to $31.0 million at December 31, 2010.  The amount of interest income “lost” on these loans was approximately $1.2 million in 2010.  The yield on loans fell to 5.75% in 2010 from 6.01% in 2009 primarily due to the effect of non-accrual loans.  Interest income on securities decreased $2.6 million from $7.5 million in 2009 to $4.9 million in 2010 due to a shift in our investment mix towards lower yielding and lower regulatory capital risk weighted GNMA and US Treasury securities.  This shift to zero percent risk weighted investments was done in order to reduce risk weighted assets, improve our risk based capital ratio and to improve the credit quality of the portfolio.  As the yields on loans and investments were decreasing, so too were the rates paid on deposits.  Interest expense on deposits decreased $3.2 million or 31.4% in 2010 compared to 2009. The yield on deposits was 2.11% in 2010 compared to 3.0% in 2009. Interest expense on borrowings decreased $0.5 million from $2.3 million in 2009 to $1.8 million in 2010 while the cost of these funds increased from 2.69% in 2009 to 3.50% in 2010.


In 2009, our net interest income was $13.0 million, compared to $14.3 million in 2008.  The principal reasons for the decline in the net interest margin in 2009 from 2008 was a decline in interest and fees on loans and a decrease in interest income on securities.  Earning assets for 2009 averaged $465.3 million, a decrease of $4.3 million or 0.9% compared to $469.6 million in 2008. The decrease in net interest income for 2009 versus 2008 of $1.3 or 9.1% resulted from the decrease of $4.1 million or 13.9% in interest income which totaled $25.4 million versus $29.5 million in 2008, this decline exceeded the reduction of $2.8 or 18.4% in interest expense which totaled $12.4 million versus $15.2 million in 2008. Due to the interest rate cuts throughout 2009, the yield on earning assets declined by 87 basis points to 5.54% from the prior year’s 6.41%, while over the same period, the expense yield on interest bearing liabilities decreased by 69 basis points to 2.94% from 3.63% in 2008. This situation where yields fall on interest bearing liabilities at a slower pace than they did on earning assets results from interest rate cuts that are not fully reflected in retail deposit pricing due to a competitive environment where the costs of deposits were at artificially high levels not reflective of the current cost environment and older certificates of deposit renewing at these higher market rates which negatively impacts the net interest margin of an asset sensitive financial institution.
 
 The table below, sets forth our average interest earning assets (on a tax-equivalent basis) and average interest bearing liabilities, the average yields earned on such assets and rates paid on such liabilities, and the net interest margin, all for the periods indicated.
 
 
Year Ended December 31,
 
 
2010
   
2009
   
2008
 
 
Average
         
Yield/
   
Average
         
Yield/
   
Average
         
Yield/
 
 
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
 
 
(Dollars in Thousands)
 
Assets
                                                   
Federal funds sold
$ 14,069     $ 32       0.22 %   $ 9,244     $ 21       0.23 %   $ 126     $ 2       1.74 %
Securities: (1)
                                                                     
U. S. Treasury and other U. S. government
                                                                 
agency and corporations
  74,836       3,264       4.36 %     92,671       4,390       4.74 %     98,066       5,301       5.41 %
States and political subdivisions (2)
  9,376       635       6.77 %     15,266       1,023       6.70 %     17,673       1,137       6.43 %
Other securities (2)
  29,407       1,116       3.80 %     49,790       2,402       4.82 %     67,254       4,135       6.15 %
Total securities (2)
  113,619       5,015       4.41 %     157,727       7,815       4.95 %     182,993       10,573       5.78 %
Loans (2)(3)(4)(5)(6)
  281,155       16,160       5.75 %     298,328       17,939       6.01 %     286,513       19,517       6.81 %
Total interest-earning assets (2)
  408,843     $ 21,207       5.19 %     465,299     $ 25,775       5.54 %     469,632     $ 30,092       6.41 %
Allowance for loan losses
  (10,227 )                     (4,344 )                     (3,308 )                
   Total non-earning assets
  48,325                       34,960                       26,374                  
Total assets
$ 446,941                     $ 495,915                     $ 492,698                  
                                                                       
Liabilities and Stockholders’ Equity:
                                                                 
Deposits:
                                                                     
Interest bearing demand
$ 81,799     $ 742       0.91 %   $ 73,131     $ 997       1.36 %   $ 62,813     $ 1,145       1.82 %
Savings
  37,515       346       0.92 %     32,937       396       1.20 %     31,729       479       1.51 %
Other time
  210,282       5,856       2.78 %     231,373       8,735       3.78 %     225,112       10,185       4.52 %
Total deposits
  329,596       6,944       2.11 %     337,441       10,128       3.00 %     319,654       11,809       3.69 %
Federal funds purchased and securities
                                                                   
sold under repurchase agreements
  3,566       22       0.62 %     26,239       213       .81 %     35,948       831       2.31 %
FHLB advances - Overnight
  3,825       15       0.39 %     11,019       51       .46 %     12,544       280       2.23 %
FHLB advances - Term
  40,000       1,637       4.09 %     41,713       1,741       4.17 %     45,000       1,875       4.17 %
Short-term borrowings
  -       -       - %     1,688       116       6.87 %     1,779       113       6.35 %
Trust preferred obligation
  5,155       164       3.18 %     5,155       189       3.67 %     5,155       324       6.29 %
Total borrowings
  52,546       1,838       3.50 %     85,814       2,310       2.69 %     100,426       3,423       3.41 %
Total interest-bearing liabilities
  382,142       8,782       2.30 %     423,255       12,438       2.94 %     420,080       15,232       3.63 %
Demand deposits
  38,163                       39,168                       39,839                  
Other liabilities
  1,869                       3,119                       3,122                  
Total liabilities
  422,174                       465,542                       463,041                  
Stockholder’ equity
  24,767                       30,373                       29,657                  
Total liabilities and stockholders’ equity
$ 446,941                     $ 495,915                     $ 492,698                  
Net interest spread
        $ 12,425       2.89 %           $ 13,337       2.60 %           $ 14,860       2.78 %
Net interest margin (7)
                  3.04 %                     2.87 %                     3.16 %
 ____________________
(1)
Includes securities available for sale and securities held to maturity.
(2)
Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental rate of 34% and totaled $219 thousand in 2010, $345 thousand in 2009 and $579 in 2008.
(3)
Installment loans are stated net of unearned income.
(4)
Average loan balances include non-accrual loans.
(5)
Interest income on loans includes the earned portion of net deferred loan fees in accordance with FASB 91 of $380 thousand in 2010, $551 thousand in 2009, and $547 thousand in 2008.
(6)
Includes mortgage loans held for sale and SBA loans held for resale.
(7)
Net interest margin is calculated as interest income less interest expense divided by average earning assets.
 
Net interest income when adjusted for the effect of non-taxable income is referred to as fully tax equivalent (“FTE”) net interest income.  On a fully tax equivalent basis, net interest income for 2010 was $12.4 million, a decline of $0.9 million or 6.8% compared to 2009.  The 2010 FTE net interest margin was 3.04% compared to 2.87% in 2009 and 3.16% in 2008.  The yield on securities decreased to 4.41% from 4.95% in 2009 as we shifted our investment mix towards lower yielding securities such as GNMA and US Treasury securities.  The yield on loans decreased to 5.75% from 6.01% in 2009 as non-accrual loans increased 42.9% from $21.7 million at December 31, 2009 to $31.0 million at December 31, 2010.  The cost of deposits decreased from 3.00% in 2009 to 2.11% in 2010 mainly reflecting a reduction of 9.1% in certificates of deposit balances and lower rates paid on new certificates of deposit.  The tax-equivalent net interest margin is a measure of net interest income performance. It represents the difference between interest income with any non-taxable interest adjusted to a fully tax-equivalent basis, including net deferred loan fees earned, and interest expense, on both deposits, and borrowings reflected as a percentage of average interest earning assets.

Net interest income on a fully tax equivalent basis for 2009 was $13.3 million a decline of $1.6 or 10.7% versus $14.9 million in 2008. The full year 2009 FTE net interest margin was 2.87% compared to 3.16% for the full year of 2008.  This was primarily due to an increase in non-accrual loans, variable rate loans repricing downward and calls being made on many higher yielding agency securities. The yield on total earning assets declined by 87 basis points, to 5.54% from 6.41% on $4.3 million less in average earning assets, and resulted largely from the decline in the yield on loans: 6.01% versus 6.81%, on an increase in loan volume of $11.8 million: $298.3 million from $286.5 million; while the yield on securities declined to 4.95% versus 5.78% on a decrease of $25.3 million in volume: $157.7 million from $183.0 million. Correspondingly, the cost of total interest bearing liabilities declined by 69 basis points: 2.94% from 3.63%, on an increase in interest bearing liabilities volume of $3.2 million: $423.3 from $420.1 million, and resulted from the decrease in the cost of interest bearing deposits of 69 basis points 3.00% from 3.69%, as volume increased by $17.7 million: $337.4 million from $319.7 million; while borrowings cost declined by 72 basis points: 2.69% from 3.41%, on $14.6 million lower volume: $85.8 million from $100.4 million.
 
Net interest income is affected by changes in both average interest rates and average volumes of interest-earning assets and interest-bearing liabilities. The following table sets forth the amounts of the total change in interest income that can be attributed to rate (change in rate multiplied by old volume) and volume (change in volume multiplied by old rate) for the periods indicated. The amount of change not solely due to rate or volume changes was allocated between the change due to rate and the change due to volume based on the relative size of the rate and volume changes.

 (Dollars in Thousands)
 
2010 Compared to 2009
   
2009 Compared to 2008
 
   
Volume
   
Rate
   
Net
   
Volume
   
Rate
   
Net
 
Interest income
                                   
Federal funds sold
  $ 11     $ -     $ 11     $ 20     $ -     $ 20  
Securities: (1)
                                               
U. S. Treasury and other U.S. government
                                               
agencies and corporations
    (801 )     (325 )     (1,126 )     (285 )     (626 )     (911 )
States and political subdivisions (2)
    (399 )     11       (388 )     (164 )     50       (114 )
Other securities
    (845 )     (441 )     (1,286 )     (946 )     (788 )     (1,734 )
Total securities
    (2,045 )     (755 )     (2,800 )     (1,395 )     (1,364 )     (2,759 )
Loans (2)
    (1,009 )     (770 )     (1,779 )     857       (2,435 )     (1,578 )
Total interest income
  $ (3,043 )   $ (1,525 )   $ (4,568 )   $ (518 )   $ (3,799 )   $ (4,317 )
Interest expense:
                                               
Deposits:
                                               
Interest bearing demand
  $ 140     $ (395 )   $ (255 )   $ 275     $ (423 )   $ (148 )
Savings
    74       (124 )     (50 )     19       (102 )     (83 )
Other time
    (743 )     (2,136 )     (2,879 )     292       (1,741 )     (1,449 )
Total deposits
    (529 )     (2,655 )     (3,184 )     586       (2,266 )     (1,680 )
Federal funds purchased and securities
                                               
sold under repurchase agreements
    (151 )     (40 )     (191 )     (181 )     (437 )     (618 )
FHLB advances
                                               
Overnight
    (29 )     (7 )     (36 )     (30 )     (199 )     (229 )
Term
    (71 )     (33 )     (104 )     (137 )     3       (134 )
Short-term note payable
    (116 )     -       (116 )     (6 )     9       3  
Trust preferred obligation
    (1 )     (24 )     (25 )     -       (135 )     (135 )
Total interest expense
  $ (897 )   $ (2,759 )   $ (3,656 )   $ 232     $ (3,025 )   $ (2,793 )
Increase (decrease) in net interest income
  $ (2,146 )   $ 1,234     $ (912 )   $ (750 )   $ (774 )   $ (1,524 )
____________________
(1)  Includes securities available for sale and securities held to maturity.
(2) Fully taxable equivalent basis using an incremental tax rate of 34%.
 
Non-Interest Income.
 
At December 31, 2010, non-interest income increased $1.6 million or 48.9% primarily due to a $1.8 million increase in realized gain (loss) on sale of securities available for sale.  Secondary mortgage market fees decreased 38.5% to $142 thousand due to lower mortgage loan origination volume.  Deposit fees and charges declined slightly by 9.7% in 2010 due to regulatory changes impacting overdraft fees.  Bank card fees increased 12.8% to $598 thousand as the fees received from credit card usage increased as the usage of credit cards increased.  The increase in cash surrender value of bank owned life insurance totaled $440 thousand versus $434 thousand an increase of $6 thousand or 1.4% as a result of higher net crediting rates paid by the insurance companies.
 
 
Non-interest income for 2009 decreased $357 thousand or 10.1%, totaling $3.2 million compared to $3.5 million in 2008 primarily due to a 265.8% decline in realized gain (loss) on sale of securities available for sale.  For 2009, we recorded a loss of $268,400 primarily due to selling two securities and recognizing actual tax-deductible losses rather than recording OTTI compared to a gain of $161,929 in 2008.  Investment and insurance commissions generated by the non-deposit investment product sales program were $162,739 in 2009 compared to $252,094 in 2008 as investors made fewer investment changes due to the economy.  Secondary mortgage market fees increased 114.81% to $230,696 due to our strategy in deciding to not keep fixed-rate loans generated in 2009 in our portfolio as we had in 2008.  Deposit fees and charges declined slightly by 2.25% in 2009 as the number of overdrafts declined.  Bank card fees increased 3.44% to $530,659 as the fees received from credit card usage increased as the usage of credit cards increased.  The increase in cash surrender value of bank owned life insurance totaled $434,693 versus $388,696 an increase of $45,997 or 11.8% as a result of higher net crediting rates paid by the insurance companies.  Other income increased $18,419 or 7.98% as we began a new agreement with our check vendor whereby commissions are directly received rather than receiving credits.  This offset a decline in the earnings from the title insurance subsidiary.
 
 Non-Interest Expenses.
 
Non-interest expense totaled $14.7 million in 2010 compared to $20.0 million, a decrease of $5.3 million or 26.5%.  Salary and benefit expense decreased by $1.0 million in 2010 primarily due to management driven headcount reductions.  The loss on OTTI write-down of securities totaled $255 thousand in 2010 compared to $6.7 million in 2009 due to improving credit markets which have not led to new material OTTI impairments on our CDO securities.  Legal, professional and consulting fees increased $935 thousand or 159.3% primarily related to increased fees associated with our written agreement with the Federal Reserve and Virginia Bureau of Financial Institutions and regulatory compliance.  The loss on devaluation of real estate owned increased to $834 thousand in 2010 from zero in 2009 due to an increase in foreclosed assets and deteriorating real estate values.  FDIC insurance premiums increased $10,000 in 2010 compared to 2009.

Total non-interest expense was $20.0 million in 2009 versus $31.9 million in the prior year, a decrease of $11.9 million or 37.3% from 2008. The largest portion of this expense in each year was the loss on OTTI write-down of securities which totaled $6.7 million in 2009 compared to $18.9 million in 2008.  Excluding OTTI, non-interest expense increased $230,392 or 1.8% in 2009.  Federal Insurance Premiums (FDIC) increased $933,324 or 424.4% in 2009 to $1.2 million.  This is primarily due to a special assessment of $226,000 expensed in the second quarter as well as premium rate increases in 2009.  In addition, data processing is a new expense category in 2009, which represents our change in late 2008 to an outsourced arrangement for data processing, replacing an in-house system.  Previously, comparable expenses would have been in salaries and wages, pensions and benefits, equipment depreciation, and equipment repairs and maintenance.  Each of these categories decreased in 2009, partially due to this new arrangement.  Advertising and public relations costs decreased $110,545 or 32.3%; consulting fees decreased $104,344 or 29.6%; and other operating expenses decreased $118,053 or 5.5% as we successfully sought to reduce costs where reasonable and practical.
  
Income Taxes.

We reported income tax expense of $9.7 million in 2010 and a benefit of $4.2 million in 2009, and a benefit of $5.7 million in 2008. The 2010 effective tax rate is primarily the result of the establishment of a valuation allowance on our deferred tax asset.  The 2009 effective tax rate benefit is the result of the write-down of other than temporary impairment on securities, increased FDIC premiums, and lower net interest income.  The 2008 effective tax rate benefit is the result of the loss suffered due to the write-off of our GSE and Lehman investments


during 2008.  Management assesses the realizability of the deferred tax asset on a quarterly basis, considering both positive and negative evidence in determining whether it is more likely than not that some portion or all of the gross deferred tax asset would not be realized. During the third quarter 2010, management conducted such an analysis and determined that an establishment of a valuation allowance of $14.3 million was prudent given our historical losses.  Management determined that a valuation allowance was still required as of December 31, 2010.  There is no impact on our calculation of Tier One Capital for regulatory purposes given the net deferred tax assets were already excluded from the calculation.
 
Financial Condition
 
Loan Portfolio. We actively extend consumer loans to individuals and commercial loans to small and medium sized businesses within our primary service area. Our commercial lending activity extends across our primary service area of Powhatan, Cumberland, eastern Goochland County, western Chesterfield, and western Henrico Counties. Consistent with our focus on providing community-based financial services, we generally do not attempt to diversify our loan portfolio geographically by making significant amounts of loans to borrowers outside of our primary service area.
 
The principal economic risk associated with each of the categories of loans in our portfolio is the creditworthiness of our borrowers. Within each category, such risk is increased or decreased depending on prevailing economic conditions. The risk associated with the real estate mortgage loans and installment loans to individuals varies based upon employment levels, consumer confidence, fluctuations in value of residential real estate and other conditions that affect the ability of consumers to repay indebtedness. The risk associated with commercial, financial and agricultural loans varies based upon the strength and activity of the local economies of our market areas. The risk associated with real estate construction loans varies based upon the supply of and demand for the type of real estate under construction. Many of our real estate construction loans are for pre-sold or contract homes. Builders are limited as to the number and dollar amount of loans for speculative home construction based on the financial strength of the borrower and the prevailing market conditions.
 
Total loans outstanding at December 31, 2010 decreased by $30.9 million or 10.6% from 2009, ending the year at $261.4 million.  In 2009, loans decreased by $1.1 million or 0.38% ending the year at $292.3 million.  In 2008 loan growth was $27.5 million or 10.4% ending the year at $293.4 million, and in 2007 loan growth was $57.3 million or 27.9% ending the year at $265.9 million. The loan to deposit ratio was 75.5% at December 31, 2010, 75.8% at December 31, 2009, 84.3% at December 31, 2008, and 74.1% at December 31, 2007.  The targeted range for the loan to deposit ratio is 70% - 85%.  We anticipate that the loan portfolio will continue to decline in 2011.
 
The following table summarizes our loan portfolio, net of unearned income:
   
At December 31,
 
   
(Dollars in Thousands)
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
Commercial
  $ 55,489     $ 67,780     $ 59,327     $ 48,255     $ 40,683  
Real Estate:
                                       
Mortgage
    126,445       126,868       124,053       106,394       78,986  
Home equity
    21,679       21,308       18,828       13,863       10,796  
Construction
    51,004       67,962       81,762       87,127       68,204  
Total real estate
    199,128       216,138       224,644       207,384       157,986  
Bank cards
    998       1,018       951       911       894  
Installment
    5,836       7,392       8,512       9,350       9,000  
 Total loans
    261,451       292,328       293,434       265,900       208,563  
Less unearned income
    (2 )     (24 )     (28 )     (51 )     (56 )
 Loans, net of unearned
    261,449       292,304       293,406       265,849       208,507  
Allowance for loan losses
    (10,524 )     (10,814 )     (3,797 )     (2,912 )     (2,889 )
Loans, net
  $ 250,925     $ 281,490     $ 289,609     $ 262,937     $ 205,618  

As the table above indicates, the total amount of commercial loans have decreased by $12.3 million, increased by $8.5 million, increased by $11.1 million, and increased by $7.5 million, or (18.1)%, 14.2%, 22.9%, and 18.6%, in 2010, 2009, 2008, and 2007 respectively. We have focused much of our efforts on increasing our commercial loans for several years, as a desirable alternative to real estate related construction lending. Total real estate related loans outstanding decreased by $17.0 million or 7.8% in 2010, $8.5 million or 3.8% in 2009, increased by $17.3 million or 8.3% in 2008, and increased by $49.4 million or 31.3% in 2007. Of the real estate related loans in 2010, mortgage loans decreased $423 thousand or 0.3%, home equity loans increased by $371 thousand or 1.7%, and construction loans decreased by $17.0 million or 25.0%.  In 2009, mortgage loans increased $2.8 million or 2.2%, home equity loans increased by $2.5 million or 13.2%, and construction loans decreased by $13.8 million or 16.9%.  In 2008, mortgage loans increased the most at $17.7 million or 16.6%, followed by home equity at $5.0 million or 35.8%, and construction loans declined $5.4 million or 6.2%. In 2007, mortgage loans increased the most at $27.4 million or 34.7% followed by construction at $18.9 million or 27.7%, and home equity loans at $3.1 million or 28.4%. Mortgage loans have comprised between 50% to 65% of the total real estate loans for the past five years. Mortgage loans to total real estate loans were 63.5% in 2010, 58.7% in 2009, 55.4% in 2008, 51.3% in 2007, and 50.0% in 2006. Home equity loans have grown steadily over the past five years from $10.8 million in 2006 to $21.7 million in 2010.  Home Equity loans to total real estate loans were 10.9% in 2010, 9.9% in 2009, 8.4% in 2008, 6.7% in 2007, and 6.8% in 2006. Bankcard loan balances outstanding were $1.0 million in 2010, and have remained relatively level over the period from 2010 through 2006 ranging from a high of $1.0 million in 2010 and 2009 to a low of $894 thousand in 2006.
 
The shift from construction to mortgage loan growth was accomplished in part by the decision in early 2007 not to sell as many mortgage loans in the secondary market. Instead those loans which met the bank’s underwriting criteria were recorded on the bank’s books as mortgage loans. In addition, most of these loans were 30 and 15 year fixed rate loans, which given the composition of bank’s portfolio of mortgage loans being mostly 3/3 and 5/5 year adjustable rate loans, the addition of fixed rate loans was desirable from an asset liability standpoint at a time when interest rates were flat and expected to trend down in the future. As a percentage of total real estate loans, construction loans comprised 25.6% in 2010, 31.4 % in 2009, 36.4% in 2008, 43.2% in 2007, and 42.0% in 2006. Considering the current state of the real estate market for new home sales, we anticipate that our construction loan portfolio will remain at approximately the same volume or will decline in the future. Substantially all construction loans are for residential construction in our principal market areas. Effective January 1, 2011, the Company ceased the origination of residential mortgage loans.  In addition, based on the requirements of the written agreement with the Bureau of Financial Institutions and the Federal Reserve, the Company is not actively seeking acquisition, development, or construction loans; however, the Company may consider such a loan on a limited basis.
 
Installment loans decreased by $1.6 million or 21% in 2010, decreased by $1.1 million or 13.2% in 2009, decreased by $838 thousand or 9.0% in 2008, and increased by $350 thousand or 3.9% in 2007. The balances of traditional installment loans declined primarily due to reduced demand resulting from the current economic environment. Installment loans increased in 2007 due to our emphasis on loan growth, however over the past several years, the balances have dropped principally due to our unwillingness to effectively compete on an interest rate basis with the captive and other finance arms of the major automobile manufacturers, coupled with the tendency of consumers to utilize equity credit lines for purposes that in the past would have been financed with traditional installment loans. We anticipate this atmosphere surrounding installment lending to continue in the future as long as the automobile manufacturers effectively subsidize the sale of vehicles through offering below market financing.
 
All concentrations of loans exceeding 10.0% of total loans at December 31, 2010 were disclosed as a separate category of loans. The following table shows the contractual maturity distribution of loan balances outstanding as of December 31, 2010. Also provided are the amounts due classified according to the sensitivity to changes in interest rates.

   
Maturing
 
   
Within 1 Year
   
1-5 Years
   
After
5 Years
   
Total
 
   
(Dollars in Thousands)
 
Commercial
  $ 31,783     $ 12,130     $ 11,576     $ 55,489  
Real Estate:
                               
     Mortgage
    3,225       6,658       116,562       126,445  
     Home equity
    74       165       21,440       21,679  
     Construction
    45,083       5,437       484       51,004  
Total real estate
    48,382       12,260       138,486       199,128  
Bank cards
    998       -       -       998  
Installment
    1,634       3,115       1,087       5,836  
     Total Loans
  $ 82,797     $ 27,505     $ 151,149     $ 261,451  
 


   
Loans maturing within
 
   
One Year
   
1 – 5 Years
   
After 5 Years
   
Total
 
 
With fixed interest rates
    $ 15,167     $ 16,594     $ 61,749     $ 93,510  
With variable interest rates
      67,628       10,911       89,402       167,941  
    $ 82,795     $ 27,505     $ 151,151     $ 261,451  
 
Loans Held for Resale. Prior to January 1, 2011, the Bank originated mortgage loans that were presold in the secondary market and carried as loans held for resale at the agreed upon purchase price. Effective January 1, 2011 the Company ceased the origination of residential mortgage loans. The Bank also provides short term financing as part of an arrangement, begun in October 2007, with Community Bankers Securities, a registered broker-dealer and SBA pool assembler for US Small Business Administration Guaranteed Loan Certificates prior to their aggregation into an SBA loan pool security. As the certificates represent the guaranteed portion of SBA loans, and have not yet been pooled into a security, they are carried at their fair market value as a component of the total loans held for resale. As of December 31, 2010, 2009, and 2008 the total of SBA loans held for sale was $339 thousand, $351 thousand, and $358 thousand, respectively. The total mortgage loans held for sale at December 31, 2010, 2009, and 2008 were $1.5 million, $1.8 million, and $744 thousand respectively.
 
Asset Quality. Non-performing loans include non-accrual loans, loans 90 days or more past due and restructured loans. Non-accrual loans are loans on which interest accruals have been discontinued. Loans which reach non-accrual status, per Company policy, may not be restored to accrual status until all delinquent principal and interest has been paid, or the loan becomes both well secured and in the process of collection. Restructured loans are loans with respect to which a borrower has been granted a concession on the interest rate or the original repayment terms because of financial difficulties.
  
Management forecloses on delinquent real estate loans when all other repayment possibilities have been exhausted. The Bank’s practice is to value real estate acquired through foreclosure at the lower of (i) an independent current appraisal or market analysis less anticipated costs of disposal, or (ii) the existing loan balance. The following table summarizes activity related to other real estate owned:
 
   
At December 31,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
   
(Dollars in Thousands)
 
Acquired real estate through foreclosure
  $ 1,980     $ 3,341     $ 1,245     $ -     $ -  
Net OREO related expenses
    72       93       18       -       -  

Management is diligently monitoring the increase in non-performing assets; however, it does believe that the level of non-performing loans in 2010 is a reflection of the current depressed real estate markets and the generally weak economic environment. Based on our present knowledge of the status of individual and corporate borrowers and the overall state of the local economy, management reasonably anticipates that the level of non-performing assets is likely to decrease from its current level. Management will move to foreclose on borrowers whose loans are placed on a non-accrual status in order to resolve the credit therefore it is reasonable to anticipate an increase in OREO.
 
Non-performing loans increased by $15.2 million in 2010 from 2009 as the current economic downturn continued to affect the ability of some of our borrowers to repay their loans.  The following table summarizes non-performing assets:
 
   
At December 31,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
   
(Dollars in Thousands)
 
Loans accounted for on a non-accrual basis
  $ 30,963     $ 21,655     $ 10,422     $ 2,361     $ 736  
Loans contractually past due 90 days or more as to interest or
principal payments (not included in non-accrual loans above)
    1,492       2,177       1,175       1,757       264  
Loans restructured and in compliance with modified terms (not
included in non-accrual loans or loans contractually past due
90 days or more above)
      6,510         -         -         -         -  
Total non-performing loans
  $ 38,965     $ 23,832     $ 11,597     $ 4,118     $ 1,000  
Other real estate owned
    2,394       3,575       1,173       -       -  
Other non-performing assets
    2,330       2,165       312       -       -  
Total non-performing assets
  $ 43,689     $ 29,572     $ 13,082     $ 4,118     $ 1,000  
 
Loans 90 days or more past due generally, are placed on non-accrual status unless well secured and in the process of collection.
 
Our policy with respect to past due interest on nonaccrual loans requires that any interest accrued in the current year and unpaid should be reversed from the receivable and current year’s income. With regard to interest accrued in the prior year, and yet unpaid, such accrued interest should be reversed from the receivable and reserve for loan losses. Since we operate in a rural to suburban area, we have generally been well acquainted with our principal borrowers and have not had such a large number of problem credits that management has not been able to stay well informed about, and in contact with, troubled borrowers. Management is not aware of any other material loans at December 31, 2010, which involve significant doubts as to the ability of the borrowers to comply with their existing payment terms.
 
The following table sets forth the amounts of contracted interest income and interest income reflected in income on loans accounted for on a non-accrual basis and loans restructured and in compliance with modified terms:
 
   
For the Year Ended December 31,
 
   
2010
   
2009
   
2008
 
   
(Dollars in Thousands)
 
Gross interest income that would have been recorded if the loans
had been current and in accordance with their original terms
  $ 1,201     $ 912     $ 355  
 
Interest income included in income on the loans
  $ 778     $ 387     $ 123  
Interest income reversed due to loans being placed on non-accrual
  $ 700     $ 621     $ 232  
  
Management has analyzed the potential risk of loss within its loan portfolio, given the loan balances, quality trends, value of the underlying collateral, and current local market economic and business conditions and has recognized losses where appropriate. Loans, including non-performing loans are monitored on an ongoing basis as part of our periodic loan review process. Management reviews the adequacy of its loan loss allowance at the end of each month. Based primarily on our loan risk classification system, which classifies all commercial loans, including problem credits according to a scale of 1-8 with 8 being a loss, additional provisions for losses may be made monthly. In addition, we evaluate the general market credit risks inherent in lending, as well as any systemic issues, as part of our enhanced loan loss adequacy analysis. Management believes that the allowance for loan losses is adequate to provide for future losses. The ratio of the allowance to non-performing loans decreased from 2009 due to some of our non-performing loans already having partial charge-offs associated with them.  Management evaluates non-performing loans relative to their collateral value and makes appropriate reductions in the carrying value of those loans based on that review.

The following table summarizes changes in the allowance for loan losses:

   
2010
   
2009
   
2008
   
2007
   
2006
 
   
(Dollars in Thousands)
 
Balance at beginning of period
  $ 10,814     $ 3,796     $ 2,912     $ 2,889     $ 2,918  
Charge-offs:
                                       
Commercial
    880       77       88       36       -  
Real estate:
                                       
 Mortgage
    924       772       -       -       -  
 Home equity
    81       199       -       -       -  
 Construction
    6,272       1,368       202       -       -  
Bank cards
    53       42       27       14       11  
Installment
    162       23       39       172       96  
  Overdrafts
    20       50       72       -       -  
Total charge-offs
    8,392       2,531       428       222       107  
Recoveries:
                                       
Commercial
    49       2       1       -       2  
Real estate:
                                       
 Mortgage
    78       -       1       -       -  
 Home equity
    6       -       -       -       16  
 Construction
    143       -       6       -       -  
Bank cards
    3       6       9       12       9  
Installment